Capital Ideas: A Social Security Bubble?

Introducing private savings accounts into the Social Security system could have a potentially huge effect on the incomes of current and future retirees. But how would the change affect CFOs and their ability to raise capital?

While increased demand may drive up the prices of corporate bonds, the release of a significant amount of government debt could dampen the beneficial environment. “The notion that the [PSA plan would force the] federal government to issue a lot more debt into a world that already has a lot of government paper” could be a problem for corporate issuers, says Joseph Minarik, a former policy director and chief economist for the House Budget Committee during the Clinton Administration. Currently, he’s the director of research at the Committee for Economic Development, which has close ties to major U.S. corporations.

Indeed, if the PSA plan floods the market with new Treasuries, the prices of both government and corporate bonds would likely drop under supply-and-demand pressures, explains Minarik. As a result, he says, companies would be forced to offer a higher yield to compensate.

The relatively fast and hefty inflow of PSA investment capital into the stock market could also create temporary volatility in equity prices. Thompson thinks that the increase in demand for shares — about 4 percent in terms of total market capitalization — would cause prices to rise. However, the price spike, albeit temporary, would be driven by legislation rather than improved corporate earnings. As a result, the inflated price would boost a stock’s price-to-earnings ratio, forcing new investors to pay more for the same corporate earning power.

Those increased share prices would improve the value of shareholders’ portfolios. But since the prices wouldn’t be driven by increased earnings, companies would find it harder to lure new investors, according to Thompson.

Indeed, the rush of capital into overvalued stocks coupled with the allure of a low-interest-rate environment could produce a stock market bubble, notes Carl Haacke, a former economic advisor to President Clinton and founder of Skylight Consulting. If such “super liquidity” ensues, CFOs could have a tough time managing their asset portfolios and even making core investment decisions, adds Haacke.

“A bubble is just a huge cascade of bad investment decisions that happens regardless of where interest rates settle,” says the consultant, whose new book Frenzy: Bubbles, Busts, and How to Come Out Ahead, analyzes investment decisions during bubble markets. “You will see a surge of demand not because CEOs are managing their companies well or identifying new innovative products or customer markets, but…[because of] legislative action,” counsels Haacke.

Marie Leone’s “Capital Ideas” column appears every other Thursday. Contact her at MarieLeone@cfo.com.

Discuss

Your email address will not be published. Required fields are marked *